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Real Estate Investing: The comps

Posted January 23, 2008

"Many a good deal has appeared to be not so good once you take a closer look at the right comps." — Justin Ford
 

Our friend Justin Ford at Early to Rise gave his readers some very sound advice if they're looking to get into the current real estate market. And I thought you'd appreciate the information, as well. You can find the article here or read on for more.

by Justin Ford, Early to Rise

Baltimore – (TFN):  My property manager in another state called me the other day with an opportunity on a small house. "Justin," he said, "it’s a 2-2, about 940 square feet, on a corner lot. It needs about $4,000 worth of work that I can do myself. Going by other homes in the area, it should be worth about $120,000 to $130,000 once it’s fixed up. We can buy it for $85,000."

"How much could we rent it out for?" I asked. Even if I’m going to quickly sell a property, I always want to know it will cash flow if I decide to - or have to - hang on to it.

"About $900 a month." That meant we’d be buying at less than 100 times the monthly rent - a ratio at which the house would comfortably cash flow.

"Why is the owner selling so cheaply?"

"The guy’s an investor who just picked it up in foreclosure. He only wholesales deals. Doesn’t fix or rent out properties."

"If your numbers check out, Tom, we can do the deal. Let me take a look at some comps."

Ah, the comps. Many a good deal has appeared to be not so good once you take a closer look at the right comps. We would soon learn that Tom’s estimated value of $120,000 to $130,000 was off by a good $20,000 to $30,000. He had made that mistake for two reasons: First, because he gave too much weight to an "on the fly" assessment by a local agent. Second, because he looked at the average sale price for a 2-2 in too broad an area.

The agent told Tom that homes in the area were selling for $113,000 to $150,000. But that was off the top of his head, without checking specific, recent comps. As for Tom’s own search for comps, he did it by zip code, and that casts too wide a net.

A zip code can include very different neighborhoods and price ranges. To get a closer idea of the true sales value of any property you buy, get comps that are as close to your target property as possible. That means begin with properties on the same street .

Real Estate Investing: Make sure you get a good deal

Now most appraisers won’t go out of their way to get comps on the same street or on an adjacent street. But simply because they may not apply this level of detail to their research doesn’t mean you shouldn’t. After all, they’re not risking any money in the deal.

Usually, appraisers want to come up with a legitimate fair market value. But, often, they’re pressed for time. So if the first comps they come across are a few blocks away, they may use those for the sake of convenience - without realizing that the neighborhood a few blocks away isn’t really comparable. So you’ll get a false reading by relying on houses in that area to gauge the value of your target property.

During the bubble, some banks would even push appraisers to justify the highest possible values. That way, banks could make bigger loans. And since, in most cases, they’d end up selling the loans, they didn’t care that the appraisals were a bit high. But, as a buyer, you never want your appraisals to be high. You don’t want to fool anyone - least of all yourself. Read on to learn how to find the true value of your potential purchase and why, even if you find the property yourself, a real estate agent may be your new best friend.

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